Discover profit drops 11% on surge in loan-loss provision

Discover Financial Services
DFS, -0.41%
reported an 11% drop in fiscal third-quarter net income amid an 80% surge to its provision for loan losses as delinquencies and charge-offs continued to rise.

While noting that the consumer environment and funding costs "continue to be challenging," Chief Executive David Nelms said the company's latest results "demonstrate the underlying quality of our customer base and reflect our disciplined loan underwriting process and multi-channel funding strategy."

For the quarter ended Aug. 31, the credit-card company - which spun off from Morgan Stanley (MS) in July 2007 - posted net income of $180.1 million, or 37 cents a share, down from $202.2 million, or 42 cents a share, a year earlier. Prior-year results included a 9-cent loss from discontinued operations related to the Goldfish business in the U.K. it sold to Barclays PLC (BCS) in late March.

Revenue fell 13% to $886.3 million.

Analysts polled by Thomson Reuters were looking for earnings of 35 cents a share and $918 million in revenue.

Return on equity - an important profitability measure at financial firms - slid to 12% from 14%.

Pretax earnings at the company's U.S. card segment fell 36% amid an 80% surge in loan-loss provisions, which were also up 30% from the second quarter. Managed net charge-offs jumped to 5.2% from 3.66% and 4.99%, respectively.

The managed 30-day delinquency rate rose to 3.85% from 3.16% a year earlier, while the 90-day rate climbed to 1.88% from 1.48%. The second quarter's rates were 3.81% and 1.96%.

Credit-card sales volume rose 5%.

As tough economic conditions and the credit crisis continue to play out, credit card issuers are hurting as cash-strapped borrowers' payments are falling, credit-card debt is rising and declining property values prevent borrowers from using their homes as a piggy bank. As a result, issuers have been forced to deepen their loss reserves amid higher defaults.

As a growing number of analysts is predicting that the credit crisis that has ramped up in recent weeks is far from over, the environment for credit-card issuers - the last in line to receive payments from customers - is growing increasingly grim. Citing the worsening U.S. economic conditions and rising unemployment, Sandler O'Neill said Wednesday it expects Discover will experience "more pronounced credit deterioration" through the end of this year and into 2009.

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